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Sunday, July 26, 2015

Grexit, De Long and the wages of Sinn

Now that the dust has settled (for a while) in Greece,
mainstream economics has been reconsidering what went wrong with Greece
and what the best solution would have been. And it now it seems that
both main wings of the mainstream: neoclassical, neoliberal Austerians
on one side; and Keynesian on the other side, agree. Grexit would have
been and still is the best solution.

De Long is just amazed and shocked that the Euro leaders continue to
demand austerity and commitment to Euro rules when it was clearly not
working. It was irrational. “Because the North Atlantic had lived
through the 1930s, I would say, this time we will not make the same
mistakes policymakers made in the 1930s. This time we will make our own,
different–and hopefully lesser–mistakes. I was wrong. The eurozone is
making the mistakes of the 1930s once again. And it is on the point of
making them in a more brutal, more exaggerated, and more persistent form
than they were made back in the 1930s. But I did not see that coming.
And so, when the Greek debt crisis emerged in 2010, it seemed to me that
because the lessons of history were so obvious, the path to the Greek
crisis’s resolution would be straightforward.”

What idiots the Euro leaders were and are. Surely they should have seen that they would need to “offer
Greece enough aid, support, additional money, debt write downs, and
debt reschedulings to make Greece better off by staying in the eurozone
than it would have been if it had exited, depreciated, defaulted, and
restructured back in 2010”?

This is what ex-finance minister Varoufakis and PM Tsipras leading
the Greek government were hoping or expecting when they negotiated with
the Troika. As Varoufakis explained his strategy: “a Marxist
analysis of both European capitalism and of the Left’s current condition
compels us to work towards a broad coalition, even with right-wingers,
the purpose of which ought to be the resolution of the Eurozone crisis
and the stabilisation of the European Union… Ironically, those of us who
loathe the Eurozone have a moral obligation to save it!”
(http://yanisvaroufakis.eu/2013/12/10/confessions-of-an-erratic-marxist-in-the-midst-of-a-repugnant-european-crisis/#_edn2)

But, as De Long says, “that did not happen”. So now, says
De Long, Grexit is the only way out. And he cites the apparent success
of Iceland, a very small country that is not even in the EU, let alone
the Eurozone, and thus was able to devalue and default to solve its debt
crisis and is now racing towards prosperity. “Just look at the relative degree of recovery–essentially complete, and none–in Iceland and Greece, respectively.”

This story of default and devaluation is just not true. Iceland did
not renege on the huge debts that its corrupt banks ran up with foreign
institutions (mainly the UK and the Netherlands). It eventually
renegotiated them and is now paying them back, like Greece. And
devaluation did not mean that Icelanders escaped from a huge loss in
living standards. They have done better than the Greeks on that score –
but Icelanders started from a much higher standard of living than the
Greeks. Even so, in euro terms, Icelandic employee real incomes fell 50%
and are still 25% below pre-crisis levels.
Yes, Iceland did nationalise its banks but then privatised them again
in record time. Two out of the three collapsed major banks in Iceland
are now owned by their creditors, not the state. The third bank,
Landsbanki, is still nationalised but that’s solely because of ongoing
court cases involving Icesave. Most of the creditors actually sold
their stakes onto foreign hedge funds. Some of the bankrupt banks only
remained in government control for a few weeks. SPRON, for example, was
merged into Arion Bank which in turn was given to its creditors a few
weeks later, essentially a free gift to Kaupthing’s foreign creditors.

Iceland’s lauded recovery model involving devaluation of its currency
was coupled with capital controls. And these remain a serious drag on
investment for the capitalist sector. Iceland is growing at 2% a year,
faster than much of Europe. But the IMF had originally forecast annual
growth of around 4.5% from 2011-2013.

Many Icelanders say they do not ‘feel’ this modest growth. Outside
booming fishing and tourism, businesses complain of stagnation. Some
80% of households are swamped in housing loan debts indexed to
inflation. Investment is under 15% of GDP, a record low. Real incomes
have dropped sharply for Icelandic households as their mortgage debt is
index-linked to inflation.
And it is not true that through default and devaluation, Icelanders
avoided the impact of austerity. Look at this chart of the degree of
change in the budget balance before interest costs as a % of national
GDPs made by governments globally between 2009 and 2014. Greece leads
the way in the degree of austerity. But look which country is second:
Iceland.
Brad de Long now reckons that the cost to the Greek economy of Grexit would be much lower than “the long-run costs of remaining in the eurozone given the required austerity now on offer from Brussels and Frankfurt.” That may be right, but the example of Iceland does not confirm it.
And neither does the traditional explanation of the Greek depression
that comes from Keynesians: too much austerity. De Long says that “the
key reason for the failure of forecasts is, of course, Brussels’s and
Frankfurt’s–and Washington’s, both at the IMF and in the Obama
administration–underestimate of the simple Keynesian multiplier at the
zero lower bound on interest rates.”

Moreover, I have shown in previous posts that the impact of austerity
on growth in Greece and elsewhere is way less than the impact of the
collapse in capitalist investment due to low profitability and high
corporate and public sector debt. As Frances Coppola recently put it, “the
story of the Greek crisis is not really one of fiscal profligacy
resulting in a “sudden stop”. It is one of PRIVATE sector profligacy
fuelled by rising external debt, itself resulting from (or caused by)
falling competitiveness.”https://thenextrecession.wordpress.com/2015/03/14/greece-keynes-or-marx/

Greek capitalism took the biggest hit to profitability from the Great
Recession and its profitability has recovered the least. In contrast,
Ireland suffered the least of three economies below, and recovered
profitability the most (although it is still down on its peak). And
this is reflected in economic growth. This explains Greece’s worse
position, not austerity as such or the failure to devalue.
Nevertheless, De Long continues to be amazed at the stupidity of the Euro leaders and the Austerians: “So
why have we not learned from our history? I still rub my eyes in
amazement: I would have thought that the Great Depression was a salient
enough event in European history that we would not be making the same
mistakes, exactly, again–and right now it looks like in what will turn
out to be a more extreme way.”

Well, now it seems that the Austerians are not so stupid because they
agree that the Greek government should opt for Grexit too. German
finance minister, Wolfgang Schauble, during the tortuous negotiations on
the ‘bailout package’ with Greece, apparently offered a deal to
Varoufakis to stump up €50bn in ‘aid’ if the Greeks opted to exit the
Eurozone.

And leading German Austerian economist and spokesman for the German Eurosceptic party, the AfD, Dr Werner Sinn agrees. “There
are not many issues on which I agree with my colleagues Paul Krugman
and Joseph E. Stiglitz and the former Greek finance minister Yanis
Varoufakis. But one of them is the view that an exit from the eurozone
would be advisable for Greece.”

Echoing the likes of Krugman and De Long, Sinn reckons that Greece
needs to devalue and this cannot be done successfully by ‘internal
devaluation’ ie cutting wages and prices as the current Troika measures
are trying to do. “The public credit has delayed a Greek bankruptcy,
but it has failed to revitalize the Greek economy. To compete, Greece
needs a strong devaluation — a relative decline of its price level.
Trying to lower prices and wages in absolute terms (for example, by
slashing wages) would be very difficult, as it would bankrupt many
debtors and tenants.”

For Sinn, the Keynesian solution won’t work, not because the
Keynesians advocate devaluation of the Greek currency to make Greek
capitalism competitive, but because they also want to increase public
spending. “What about the solution favored by leftists: more money
for Greece? No doubt, enormous government spending would bring about a
Keynesian stimulus and generate some modest internal growth. However,
apart from the fact that this money would have to come from other
countries’ taxpayers, this would be counterproductive, as it would
prevent the necessary devaluation of an overpriced economy and keep
wages and prices above the competitive level.”

That’s why, for Sinn, Grexit would only work if it makes the Greek
capitalist sector profitable and more competitive (at the expense of
labour). Here Sinn spells out the perfectly rational logic of austerity
that De Long and the Keynesians fail to understand. Austerity is not
just some stupid ideological prejudice on the part of the likes of
Schauble and Sinn (although it may be that too), it is a solution aiming
to restore the profitability of Greek capital, just as it offered for
other capitalist economies in this depression. See my post https://thenextrecession.wordpress.com/2015/04/24/austerity-has-it-worked/.

Sinn offers not the example of Iceland, as the Keynesians do, but the example of Ireland: “The
Irish tightened their belts and underwent a drastic internal
devaluation by cutting wages, which in turn led to lower prices for
Irish goods both in absolute and relative terms. This made the Irish
economy competitive again.” And they sure did ‘tighten their
belts’. In my graph above of changes in government budgets since 2009,
Ireland comes next after Greece and Iceland. Indeed, see Michael Taft’s
excellent article on the Irish model for Greece: http://www.theguardian.com/world/economics-blog/2015/jul/10/ireland-no-model-greece-troika-austerity

Sinn also neglects to mention that the main reason that Ireland has
become competitive has been the mass emigration of the labour force and
the special tax conditions provided by Irish governments for American
multi-nationals to operate there. Irish emigration is now back at
levels not seen since the dark days of late 1980s.
It is the same story with Estonia, another example of successful
‘austerity’ and now, of course, in Greece, Spain and Portugal. The
Austerians rest their claims for recovery for these weak capitalist
economies on huge reductions in wages and conditions for labour, massive
cutbacks in public spending and mass emigration. All this is to
restore the profitability of the capitalist sector.

But, it seems that Sinn and others now reckon that the policies of
austerity alone will not be enough to get Greek capitalism back on its
feet, however, tottering. Better now that Greece leaves, devalues its
drachma and then carries through austerity measures. “Greece would
have the option to return to the eurozone, at a new exchange rate, after
carrying out institutional reforms — such as public recording of land
purchases, functioning tax collection, accurate statistical reporting —
and meeting the normal conditions for eurozone membership. It could take
five or 10 years.”

For as Sinn puts it, “Until Europe is turned into a federal state
— as it should become, at some point — it will not have a currency like
the dollar. Until then, what is needed is a “breathing” currency union,
with orderly entry and exit options, coupled with an insolvency rule
for member states.”

So there we have it. The Keynesians say the way forward is through
Grexit and so now do many Austerians. Both see Grexit as a solution to
save Greek capitalism. The Keynesians reckon it will ‘free’ Greek
capitalism from austerity. The Austerians reckon it will ‘free’ the Euro
leaders from the wasted funding of a failing capitalist economy. But
neither side is right if the profitability of capital does not recover
in Greece and in Europe.